The golden state's retail bounty

Sep 01, 2001

Californians have had front-row seats in the recent travails of the U.S. economy: Their skyrocketing energy bills turned the state into a poster child for the national energy crisis, and the disappearing act of start-ups in Silicon Valley came to symbolize the tarnished hopes of the New Economy. Nonetheless, don't count California out just yet: A recent Shopping Center World roundtable reveals plenty of optimism among retail real estate executives working in the state. “The California economy is extremely diverse and will certainly provide healthy long-term growth,” notes roundtable participant Stuart Gulland, CEO of Manhattan Beach-based Center Trust. Sounding a similar note, roundtable participant Stephen Hopkins, Chairman and CEO of Newport Beach-based Hopkins Real Estate Group, says the economic slowdown might be exaggerated: “We are really seeing a lot of opportunities and consider this particular time one of the best to acquire and develop projects.”

SCW: How has the energy situation affected your centers? Are retailers doing anything to minimize the high cost of utilities?

EYRICH: As a landlord, we do regular periodic “audits” of our center common areas to identify ways to manage and operate properties more efficiently. The current energy situation gave us reason to focus on power usage. Implementation of a variety of measures, such as upgrading digital timers, reducing operating hours for fountains, and limiting use of architectural and decorative lighting, have enabled us to achieve savings and conserve energy. We have observed many tenants, particularly larger tenants, are reducing light levels within their stores and adjusting in-store temperatures to conserve energy.

TANZ: We have been very fortunate to-date to have not experienced any material impact at the 58 properties that we have in California. The increases in utility costs have only been modest, and have had no impact on the CAM costs our retailers pay. As an example, the electrical costs during the first quarter of this year only increased by about 2.5% over the same period last year, and electrical costs only account for about 4% of the total operating expenses, making this a negligible impact to the overall expenses.

As a precautionary measure, during the first quarter we completed a portfolio-wide initiative whereby our parking lot lighting has been individually monitored enabling us to turn off approximately 50% of the lighting when the center is closed. This will reduce overall consumption by 20% to 30%. Our tenants, too, have implemented energy consumption reduction plans. And the supermarket tenants have back-up generators to guard against temporary power outages to protect their refrigeration system.

ACKLES: We have developed short- and long-term energy management plans that have allowed us to respond immediately to the current energy crisis and plan for long-term investment in energy asset upgrades. By shutting off unnecessary lighting, raising temperature set points and other conservation initiatives, we have been able to reduce our load on the utility grid by as much as 10%. In partnership with Enron Energy Services we have begun to upgrade our lighting, HVAC and control system equipment to reduce consumption and operating costs long-term. Many of our retailers are supporting our efforts and are taking similar actions.

SCW: Has the economic slowdown in the last few months affected your projects? What are you experiencing in terms of new tenant interest, leasing pace, rent growth, tenant turnover?

HOPKINS: Even though there has been somewhat of an economic slowdown in the United States, we are really seeing a lot of opportunities and consider this particular time one of the best to acquire and develop projects. For the most part, what we are seeing in California is a concern that there is a general slowdown in the economy, but it will be short-lived, and due to the potential of “boom” in the years to come in California, this is completely overshadowed. There was a recent article in The Los Angeles Times that basically stated that California's economy had now surpassed France. With respect to retailers, even though they are being cautious, again, most retailers we are talking to see the benefit of locating new stores in California.

GULLAND: Retailers have certainly become more selective and judicious in their site selection. However, we continue to see a high level of interest in expanding into areas that will effectively generate new net income.

Retailers recognize that any short-term disruption will not diminish the positive long-term outlook for our region.

EYRICH: I'm not sure we have seen the full effect of an economic slowdown yet. While we have noticed an increased caution, our leasing has been strong, and rent growth consistent. We have seen some tenant bankruptcy filings, but nothing extraordinary, and these have not materially impacted our portfolio. Tenant retention has remained high. However, we are being conservative in our outlook for the coming year, projecting lower sales and rent growth.

TANZ: Pan Pacific is focused on owning neighborhood shopping centers located in the core growth markets in Northern and Southern California. To date we have not seen an impact at our centers as it might relate to an economic slowdown. As an example, during the first quarter of 2001 we experienced record leasing activity and quarter after quarter we continue to achieve double-digit growth in same-store rents.

We believe the continued demand for retail space at our centers is a result of a few key factors. First, would be the product type — neighborhood centers for everyday essentials. One of the benefits of our sector of real estate is the consumers' continual need to shop for what we term “everyday essentials” or the goods and services people demand, day-in and day-out.

A second key factor is the location of the properties. We focus on owning centers positioned at irreplaceable locations, being that they are situated in thriving markets, at infill locations. Both of these factors have allowed us to see our centers continue producing strong sales for our retailers.

“There was a recent article in The Los Angeles Times that basically stated that California's economy had now surpassed France.” — Stephen Hopkins

JOHNSTON: The economic slowdown hasn't affected our projects in any way. Sales in Northern California continue to increase as a result of the continued population growth in the area. Tenant interest remains high because of continued growth, diversification of industries, and sales increases. The population group — and therefore the tenant groups serving them — most affected will be low- to lower-moderate-income customers because power and gas constitutes a larger percentage of their total income and therefore disposable income. The people who lost a tremendous amount of “paper wealth” in the dot.com bust are a very small percentage of workers in the market.

SCW: In your opinion, which areas of California are seeing higher demand?

JOHNSTON: We've seen it in higher income demographic areas, tourist markets, and those markets where the population growth has exceeded the creation of new retail projects.

SCW: How has the regulatory environment in California, particularly growth and environmental issues, affected your recent development projects?

EYRICH: Projects generally take longer to entitle, gain master plan approvals, and clear environmental hurdles. Water quality has become a significant issue lately, affecting every stage of development, from planning to construction to ongoing operations. We have implemented new policies and procedures to ensure consistent compliance with regulations concerning storm water runoff.

GENOVESE: The regulatory environment in California has not impacted our development activities as we are not typically a ground-up developer. Our recent projects were mall renovations and/or expansions, which do not typically require extensive environmental reviews. For ground-up developers there is definitely an extensive process to go through in California in order to get projects entitled. This process requires the use of knowledgeable and respected consultants and must be actively managed by the developer so that entitlements are obtained in a timely manner.

HOPKINS: Since our niche is developing in urban-infill areas — public/private partnerships with municipalities — we have not really come across regulatory and environmental issues. Given that we are working in infill areas, most of our projects are either raised and new projects are developed, rehabilitation of existing projects, or even creating mixed-use opportunities. Working in infill areas goes to the core of our business plan. One of the main reasons why we are involved in this niche is we do not run into environmental or growth related issues that could stop a potential development.

SCW: Long term, how do you feel about California's prospects for positive growth?

EYRICH: Looking at the underlying fundamentals, I believe California's long term growth prospects are excellent. The energy situation is a temporary problem that will get solved, but it won't be easy or inexpensive. The current economy is marked by a lot of conflicting indicators. On the one hand, you have rising unemployment rates, daily earnings warnings, and continuing shakeout in the tech area. But on the other hand, you have interest rate cuts, tax cuts and rebates, home values increasing, and consumer confidence high. Many commentators are saying we have seen the bottom of the dip in the economy, and that recovery will occur in the second half of this year, continuing into 2002. Over the long haul the California market will continue prospering.

GULLAND: The California economy is extremely diverse and will certainly provide healthy long-term growth. Continued population growth and increased ethnic diversity will provide opportunities for those able to understand and capitalize on these trends.

JOHNSTON: California's population growth creates as many opportunities as it does problems. The Central Valley will continue to be the beneficiary of the growth in the major metro areas, in terms of housing growth as well as its ability to provide employment opportunities and services to the major metro areas. It will also continue to lead California in affordable housing.

HOPKINS: I feel the long-term prospects for California are as good as anywhere in the country. It is projected that within the next 10 years, there will be an additional 10 million people in California. The health of California's economy will not just depend on one or two areas. Also, you are going to see a tremendous amount of development and redevelopment in the core areas, and most all of the municipalities in California are open for business. There will be continued growth in master-planned areas such as Valencia — which is being expertly developed by The Newhall Land and Farming Company — and which will surpass any other area in Los Angeles.

SCW: What is the most innovative and interesting new retail concept you have seen in the last 12 months?

EYRICH: It goes back a bit more than 12 months, but I continue to be impressed by Tommy Bahama. I don't think I have ever seen a retail idea, story and product line delivered so strongly in a retail store. The other concept that comes to mind is Sephora. They created a new product through innovative and dramatic merchandising of an existing commodity.

There is still a lot of room for innovation, though. For example, I would like to see someone roll out a really wonderful travel store concept. If licensing and royalty issues can be sorted out, a music store where custom mixed MP3 downloads or CDs can be created and purchased on-site could revolutionize the way music is sold. Any number of store concepts will emerge to address the needs and wants of the aging baby boomers. There are still a lot of great ideas for exciting stores out there.

SCW: Over the years, we have seen the birth of new shopping center formats — power centers, entertainment centers, etc. What's the next new format you see on the horizon?

EYRICH: The buzzwords of the day seem to be “lifestyle” and “hybrid.” But I think it may be more than buzz. Developers do need to focus on the changing tastes of consumers and create centers and environments that respond to not only the customers' shopping habits, but also the way they live. In their purest forms, that is what these centers try to do.

I think we will see continued adaptation in this area. The department stores are all talking about new store formats for non-traditional centers. I think this is something we will be seeing in the next few years, and I think it will be exciting.

GENOVESE: In the past 10 years there have been a lot of new shopping center formats that developers have built, and then studied and modified by other developers building later projects. The most recent format appears to be urban mixed-use projects. While these types of projects are only viable in certain locations, the philosophy behind them is a trend that can be applied to a wider universe of retail properties. The conglomeration of uses such as retail, housing, service, office, entertainment and dining really is the key to creating a vibrant and successful project. Incorporating these uses into an existing shopping center will create more of a town center-type environment and ambiance, which would endear the property to the community it serves. Creating this type of environment in an age when people have less free time, will create an experience that cannot be replicated, by shopping by phone or through the Internet. It responds to the basic social desire of people to interact with other people. We can provide the experience in which this interaction can happen and be enjoyed.

SCW: Are you involved in any redevelopment projects in urban infill areas of the state? If so, have you run across any noteworthy challenges or trends presented by such projects?

HOPKINS: We are involved almost exclusively in developing projects in redevelopment areas and working with the municipalities in public/private partnerships. The challenges in working in this niche are fairly uniform: There is a need to be properly staffed as a company to understand working in this area. Even though there are tremendous amounts of economic benefits to the developer and retailer, each redevelopment deal is complicated and the ability to understand the economics and both sides of the tables, so to speak, is always a challenge.

It is also always a challenge to make sure that the municipality and staff and elected officials are in sync. In many cases, the staff might be supportive of a project, and the city council might not, or vice versa. Understanding and listening to the goals of a municipality is very important and sometimes confusing. In most cases, in working on existing projects, there is a need to negotiate with tenants through the eminent domain process. This can be very time-consuming and complicated.

GULLAND: Center Trust is currently involved in two major Los Angeles County projects, Baldwin Hills-Crenshaw Plaza in Los Angeles and Media City Center in Burbank. These projects have demonstrated that creativity and sensitivity are extremely important to the success of infill projects.

At Baldwin Hills-Crenshaw Plaza, we saw the potential to integrate Wal-Mart into an established urban retail destination. We helped them understand the opportunity created by the tremendous residential density and overcome the challenge of merchandising from a three-level historic structure. Crucial to the success of this project has been our close communication and collaboration with community leaders and elected officials.

At Media City Center in Burbank, a key consideration has been dealing with the relationship of our project to the entire downtown retail, restaurant and entertainment destination. We have fully integrated the new “power retail” element of our project into an established retail, entertainment and restaurant destination. This integration creates a win-win for both the new and established retailers.

It is clear to us that these are each unique projects, which take experience, discipline and patience. The real opportunity is to capitalize on the proven demand that exists in these marketplaces. The opportunity is tremendous if you do it right.

“The buzzwords of the day seem to be ‘lifestyle’ and ‘hybrid.’ But it might be more than buzz. Developers do need to focus on the changing tastes of consumers.” — Keith Eyrich

GENOVESE: We are not currently involved in any urban infill projects within the State of California. However we do own the Westside Pavilion in West Los Angeles, which is located in a very urban environment. We purchased this property in July of 1997 and completed an $8 million renovation of it in November of 2000. Given the proximity of this project to residential neighborhoods, we needed to be sensitive to our nighttime construction activity and schedule the renovation work in a way that did not impact our neighbors. As a follow up to the renovation we are currently looking at various options to redevelop Westside Too, which was built in 1991 and consists of a three-level, open-air retail building. Redevelopment options may include mixed-use scenarios. When considering various redevelopment options, we have engaged the community on a regular basis in order to understand what uses they would like to see as part of their community. Outside of California we are working on two projects that would be considered urban infill projects: Queens Center in the Borough of Queens, New York City and Redmond Town Center in Redmond, Wash.

SCW: What are your thoughts on recent activity in tenant location and expansion in California?

JOHNSTON: There continues to be a tremendous amount of tenant interest in the centers that serve the more affluent areas in the state, that also have long-term records of high sales performance. However, tenants are being more flexible in terms of the type of centers they locate in. While there continues to be significant activity in the high-performing regional and super-regional centers in the upscale markets, there are also projects and retail street fronts near those centers that have benefited from the high occupancy.

SCW: How has the recent downsizing of Internet-related companies affected California real estate, retail in particular?

JOHNSTON: Retail has remained largely unaffected. Those who had money before the dot.com bust still have money. Those people who created and then lost a lot of paper wealth had a larger impact on the car and home buying markets than they did pure retail markets. While there will certainly be some trickle down which affects retail, the larger impact in the real estate sector should be a cooling in the office and housing markets.